Coordination of Monetary and Macro-Prudential Policies

Release date

27 March 2014

The Reserve Bank sees a case to
coordinate its monetary and macro-prudential policies, such as loan to value
ratios, when the effects of those policies overlap, Deputy Governor Grant
Spencer says in a speech today to the Credit Suisse Asian Investment
Conference.

"We believe it is essential to retain clear primary objectives for both
monetary and macro-prudential policy. These primary objectives are price
stability and financial system stability respectively. However, there is an
appropriate role for policy coordination in certain circumstances and with
certain policy tools. The key in this respect is to ensure that the primary aims
of the two policy arms are not undermined by too heavily diverting the attention
of those policies to secondary objectives."

Mr Spencer said that the Bank's preferred approach is to allow monetary
and macro-prudential policies to support each other, conditional on each policy
retaining a clear focus on its primary objective. This approach is consistent
with the Bank's current mandates under the Policy Targets agreement (PTA)
for monetary policy and the macro-prudential MOU with the Minister of
Finance.

"Macro-prudential tools vary in their ability to affect the
macro-economy. Also, if they are pushed too hard they can lead to
disintermediation and efficiency costs. Monetary policy can have a significant
influence on financial stability, but if diverted too far from its main purpose
could undermine confidence in the commitment to price stability."

Mr Spencer said that the Loan-to-Value Ratio (LVR) ‘speed limit'
introduced last October was aimed at reducing the threat to financial stability
by dampening the rapid growth in house prices and strengthening
households' and banks' balance sheets.

"They have also been an important consideration in the Reserve
Bank's monetary policy assessment. The dampening effect of LVRs on house
price inflation is estimated to have reduced CPI inflation pressures by an
amount equivalent to a 25-50 basis point increase in the OCR. In this respect,
the LVR restrictions may have reduced current pressures on the NZD exchange
rate."

Mr Spencer said that the monetary policy tightening cycle that has now
commenced was motivated by the need to maintain CPI inflation in the vicinity of
2 percent over the medium term. In doing so, it should contribute to financial
stability by further dampening house price inflation. In this respect, an
interest rate move back to more normal levels will give the Bank greater scope
to ease or remove the LVR restrictions.

"We have stated that the LVR restrictions are not intended to be
permanent. They will be removed once housing market pressures have moderated and
when we are confident there will not be a resurgence of house price inflation in
their absence."

Mr Spencer noted that further research is underway to improve the
Bank's understanding of interactions between the two policy arms.

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